Amortization of Long-Term Debt

by Robert Shaftoe; Updated September 26, 2017

Long-term debt is recorded on a company's balance sheet to reflect any lending agreements the company has entered into as the borrower, under which payments are due after the upcoming fiscal year. The payments can be monthly, quarterly or yearly, and can include both interest and principal. When debt is initially issued, it is recorded on the balance sheet at its face value. As the company makes related interest payments and principal repayments, the carrying value of the debt is adjusted on the balance sheet. This is done by amortizing the debt, which involves calculating the interest and principal portions of the debt separately, allowing for the recording of interest expense and the making of adjustments to the debt's carrying value on the balance sheet.

Debt amortization is typically performed using an amortization table, which contains columns for the beginning loan balance, the interest component of the loan payment, the principal portion of the loan payment, and the ending loan balance. Each row in the table reflects a new payment period.

Sample Amortization Calculation

Assume a company receives a five-year loan with a stated value of $1,000, payable at 10 percent, requiring 60 (five years multiplied by 12 months per year) monthly payments of $21.25. Interest expense for the first period is calculated by applying the interest rate to the loan principal. The stated annual percentage rate of 10 percent is converted to a monthly rate by dividing 10 percent by 12 months, resulting in an interest rate of 0.833 of 1 percent.

The first month's interest expense is equal to 0.00833 multiplied by the loan balance of $1,000, which equals $8.33. The monthly payment of $21.25 minus the interest portion of $8.33 equals the amount by which the loan balance is reduced, $12.92. Therefore, the ending loan balance equals $1,000 minus $12.92, or $987.08. These figures are displayed in the first row of the amortization table, each in its own column, as $1,000, $8.33, $12.92 and $987.08.

The loan value as of the end of period/month one is carried down to the first column of the second row as the beginning loan balance. The interest rate is applied to the beginning loan balance of (0.00833 x $987.08), resulting in interest expense of $8.22. The principal reduction is equal to $21.25 minus $8.22, which equals $13.03. The ending loan balance is calculated by subtracting $13.03 from the beginning loan balance of $987.08, yielding $974.05.

This process is updated with each month's payment made, until the loan balance reaches zero. Each period's interest expense is accounted for in the income statement, and the ending loan balance is reflected on the balance sheet.